by Zubin Driver
May 27, 2010
The month of May has turned the serene, seemingly relentless climb for stock markets that had been in effect since mid-February upside down. Volatility increased a few weeks ago when it was revealed that Goldman Sachs, America's leading investment bank, was being investigated by the SEC, an investigation which was expanded shortly thereafter, to become a criminal investigation conducted by the American justice department. Goldman has been accused of selling its clients a product filled with subprime mortgage securities that was designed to go down, a design feature that Goldman failed to share with said buy-side clients when they purchased the product in 2007.
Since then, the European debt crisis, ongoing for months now, has escalated significantly. In early May, Standard & Poor's downgraded Greek bonds to 'junk' status. The downgrade caused the spread between Greek and German bonds to shoot up by 3%, from roughly 6 to 9% in one day, before German assurance that a bailout package would be shortly passed, at which point the spread again narrowed back to 6%. No small move by bond market standards! The same day S & P also downgraded Portugese bonds, and the next day followed with a downgrade of Spain's debt as well.
It has been frequently repeated that the Greek economy is too small to have a significant effect on global markets of the sort that occurred in the turmoil of 2008. This notion is true, but in the highly interconnected global economy, outcomes such as default, or the downgrade of bond ratings to junk status are significant in terms of their ability to drag down other governments and financial institutions who hold the debt of a defaulting or downgraded nation. Due to the fact that most governments took over private sector debt during the 2008 financial crisis in order to stabilise the global market economy, they are already heavily indebted and thus more vulnerable to shocks such as the European debt crisis. Further, ratings agencies and market participants are worried that other European countries have similar problems to Greece, which would require an ever-expanding series of bailout programs. This concern was reflected all over the media 2 weeks ago, via the buzzword 'contagion.'
As banks grow concerned about Greek, Portugese, Spanish, Irish, and Italian debt woes, their wariness regarding other banks' exposure to these countries' debt grows as well. As a result, interbank lending has begun to 'freeze up ,' (ie. banks are hesitant to lend to each other and demand higher rates to do so) just as it did during the credit crunch. The results of this slowdown in lending was immediately tangible in the markets, which became panic stricken in a way that hadn't been felt since the '08 crash: suddenly everyone was watching the VIX (volatility index) shoot up, as well as LIBOR (the London Interbank lending rate), which measures the interest rate level that banks charge each other on overnight loans. Most reminiscent since the crash, however, was the 1000 point intraday drop in the Dow, which reversed back up to 'only' close down roughly 350 points.
Bailouts are Back
Two weeks ago a 110 billion Euro bailout plan for Greece, funded by the EU and IMF, was announced, which the market greeted well, rising almost 200 points, the Monday after the plan was announced. Yet the rest of the week gave way to an aggressive sell off, culminating in the biggest intraday drop on the Dow Jones Industrial Average in history, as fear of contagion and a refreezing of credit markets gripped investors. The following weekend, a second, much larger bailout package was approved (750 bln Euros), again from the EU and IMF, thus including smaller contributions from other central banks such as the US and Canada. The funds will be used for loan guarantees, further loans, and also for buying bonds in the open market to keep borrowing costs down.
So a familiar dynamic has reasserted itself. Market panics, government steps in, market turns green again in approval of guarantees and easy money. For now, it appears that the first round of this dynamic worked out, as the stimulus effort of the last 18 months did lead to an improved macroeconomic picture and a return to rising asset prices. Should the EU bailout package lead to highly indebted European governments' managing to control their finances, then their credit markets and borrowing costs should also recover. Yet, as recent unhappy reactions by workers in Greece to their government's efforts to introduce austerity measures show, the task of reigning in spending, will not be easy.
The lonely winner
Unless one has been buying the VIX or shorting the market, there have been few or no profitable areas, other than gold. Indeed, other commodities, especially those conventionally thought of as economic gauges like oil and copper, have been relentlessly plummeting. On the day of the astounding 1,000 point drop in the dow, gold shot up by about $30 / ounce, and traded to new highs of almost $1250 / ounce the following morning. This increase represented the type of 'safe haven' buying that one expects but doesn't always see, as gold is said to be a hedge against uncertainty and inflation. It is also said to be a fiat currency, and if one believes that the Euro may be doomed to extinction, a belief that is clearly strengthening in recent weeks, than this further helps to account for the recent rise. Not surprisingly, suddenly one hears forecasts of $2 - 3000 per ounce in coming years, as the metal is now trading at new highs. For producers, the increase is certainly a benefit that gets reflected in share prices. Yet, for a number of explorers and smaller companies, a market that is becoming more risk-averse unfortunately seems to be saying 'who cares' regardless of the gold price. Hopefully, a discovery during the busy arctic exploration season this summer may provide some excitement and give life to the currently moribund junior sector.
Best regards,
Zubin
Zubin Driver
Investment Advisor
(W) 604 643-7608 / (F) 604 643-7606
Email: zubin_driver@canaccord.com
Canaccord Wealth Management
Attention: Zubin Driver
P.O. Box 10337 Pacific Centre
2200 - 609 Granville St.
Vancouver, B.C. V7Y 1H2
CANACCORD WEALTH MANAGEMENT IS A DIVISION OF CANACCORD GENUITY CORP., MEMBER-CANADIAN INVESTOR PROTECTION FUND
MEMBER OF ALL CANADIAN STOCK EXCHANGES AND THE INVESTMENT INDUSTRY REGULATORY ORGANIZATION OF CANADA
OFFICES IN MAJOR CENTRES ACROSS CANADA
This newsletter is solely the work of the author for the private information of clients. Although the author is a registered Investment Advisor at Canaccord Genuity Corp., this is not an official publication of Canaccord Genuity Corp. and the author is not a Canaccord Genuity Corp. analyst. The views (including any recommendations) expressed in this newsletter are those of the author alone, and are not necessarily those of Canaccord Genuity Corp.
The information contained in this newsletter is drawn from sources believed to be reliable, but the accuracy and completeness of the information is not guaranteed, nor in providing it do the author or Canaccord Genuity Corp. assume any liability. This information is given as of the date appearing on this newsletter, and neither the author nor Canaccord Genuity Corp. assume any obligation to update the information or advise on further developments relating to information provided herein. This newsletter is intended for distribution in those jurisdictions where both the author and Canaccord Genuity Corp. are registered to do business in securities. Any distribution or dissemination of this newsletter in any other jurisdictions is prohibited. The holdings of the author, Canaccord Genuity Corp., its affiliated companies and holdings of their respective directors, officers and employees and companies with which they are associated may, from time to time, include the securities mentioned in this newsletter
|
